Financial institutions and productive efficiency: A redefinition and extension

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Banks are found to have substantially lower average efficiency than indicated by previous studies. Efficiency is determined by sample size, the number of inputs and outputs of the model, the choice of input and outputs and the degree of homogeneity of the sample. Homogeneity appears to be one of the stronger drivers of average efficiency. Some intermediation models may be biased toward finding higher average efficiency and lack criteria to determine whether the intermediation process is profitable. The average bank is found to be competitive, but the low average efficiency scores found seems to be a result of a small percentage of banks that temporarily manage to attain some degree of super-efficiency. The inputs and the outputs used in data envelopment analysis are standardized by utilizing accounting definitions and foundational finance concepts. This allows modeling a bank’s productive process for the measurement of total productive efficiency and provides a way to include the profitability of a bank productivity process. This standardized model can then be extended to analyze other industries.
Open-ended mutual fund efficiency is examined utilizing data envelopment analysis. Inputs and outputs are standardized and then extended utilizing the flexibility of the data envelopment analysis approach. Risk and return are modeled as joint outputs. This is consistent with the idea that there is a tradeoff between risk and return. Because of the joint nature of risk and return and their use as joint outputs, the approach used here does not require specifying the nature of the risk/return tradeoff. The effect of 12b-1 fees on mutual funds is examined from an efficiency point of view. Consistent with previous literature using much different techniques, the imposition of 12b-1 fees is found to be detrimental to fund efficiency. Funds with 12b-1 fees are shown to have higher expense ratios net of the 12b-1 fee than funds that do not have 12b-1 fees. Finally, funds that increase in efficiency are shown to do so by producing higher returns, generating fewer expenses and reduce their risk.